Indicate by check
mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is a
large accelerated filer, an accelerated filer or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of
the Exchange Act. (Check one):

Large accelerated filer x

Accelerated
filer o

Non-accelerated
filer o

Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No x

The number of shares
outstanding of the Registrants only class of common stock as of July 30, 2007
was approximately 103,479,000.

Watson
Pharmaceuticals, Inc. (Watson or the Company) is primarily engaged in the
development, manufacture, marketing, sale and distribution of brand and off-patent
(generic) pharmaceutical products.
Watson was incorporated in 1985 and began operations as a manufacturer
and marketer of off-patent pharmaceuticals.
Through internal product development and synergistic acquisitions of
products and businesses, the Company has grown into a diversified specialty
pharmaceutical company. Watson operates
manufacturing, distribution, research and development and administrative
facilities primarily in the United States of America (U.S.).

The accompanying
Condensed Consolidated Financial Statements should be read in conjunction with
the Companys Annual Report on Form 10-K for the year ended December 31,
2006. Certain information and footnote
disclosures normally included in annual financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
from the accompanying Condensed Consolidated Financial Statements. The year end balance sheet was derived from
the audited financial statements. The
accompanying interim financial statements are unaudited, but reflect all
adjustments which are, in the opinion of management, necessary to present
fairly Watsons consolidated financial position, results of operations and cash
flows for the periods presented. Unless
otherwise noted, all such adjustments are of a normal, recurring nature. Certain reclassifications, none of which
affected net income or retained earnings, have been made to prior period
amounts to conform to current period presentation. The Companys results of operations and cash
flows for the interim periods are not necessarily indicative of the results of
operations and cash flows that it may achieve in future periods or for the full
year.

On November 3, 2006, the Company acquired all the
outstanding shares of common stock of Andrx Corporation (Andrx) for $1.9
billion (the Andrx Acquisition). Prior
to the Andrx Acquisition the Company held common shares in Andrx, which were
previously classified as available-for-sale securities and recorded at fair
value based upon quoted market prices with temporary differences between cost
and fair value presented as accumulated other comprehensive income within
stockholders equity, net of any related tax effect. As required by Accounting Research Bulletin (ARB)
No. 51, Consolidated Financial Statements (ARB 51), earnings (loss) on
equity method investments has been restated for the three and six months
ended June 30, 2006 to account
for our investment in common shares of Andrx prior to the Andrx Acquisition
using the equity method of accounting in accordance with Accounting Principles
Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments
in Common Stock (APB 18). Other
comprehensive income has also been restated for the three and six months
ended June 30, 2006 to reflect these
changes.

Comprehensive
income includes all changes in equity during a period except those that
resulted from investments by or distributions to the Companys
stockholders. Other comprehensive income
refers to revenues, expenses, gains and losses that, under generally accepted
accounting principles, are included in comprehensive income, but excluded from
net income as these amounts are recorded directly as an adjustment to
stockholders equity. Watsons other
comprehensive income is composed of unrealized (losses) gains on its holdings
of publicly traded debt and equity securities and foreign currency translation
adjustments. The components of
comprehensive income, including attributable income taxes, consisted of the
following (in thousands):

As of June 30, 2007 and December 31, 2006, 2,500,000
shares of no par value per share preferred stock were authorized, with none
issued. As of June 30, 2007 and December
31, 2006, 500,000,000 shares of $0.0033 par value per share common stock were
authorized, with 112,856,000 and 111,867,000 shares issued and 103,456,000 and
102,467,000 outstanding, respectively.
Of the issued shares, 9,399,800 shares were held as treasury shares as
of June 30, 2007 and December 31, 2006, respectively.

On February 15, 2006, the
Companys Board of Directors authorized the expenditure of $300.0 million to
repurchase shares of the Companys outstanding common stock (the 2006
Repurchase Program). No common stock
was repurchased under the 2006 Repurchase Program which expired on February 15,
2007.

As customary in the pharmaceutical industry, the Companys gross
product sales are subject to a variety of deductions in arriving at reported
net product sales. When the Company
recognizes revenue from the sale of its products, an estimate of sales returns
and allowances (SRA) is recorded which reduces product sales and accounts
receivable. These adjustments include estimates for chargebacks, rebates, cash
discounts and returns and other allowances.
These provisions are estimated based
on historical payment experience, historical relationship to revenues,
estimated customer inventory levels and current contract sales terms with direct
and indirect customers. The estimation
process used to determine our SRA provision has been applied on a consistent
basis and no material adjustments have been necessary to increase or decrease
our reserves for SRA as a result of a significant change in underlying
estimates. The Company uses a variety of methods to assess
the adequacy of our SRA reserves to ensure that our financial statements are
fairly stated. This includes periodic
reviews of customer inventory data, customer contract programs and product
pricing trends to analyze and validate the SRA reserves.

The provision for chargebacks is our most significant sales
allowance. A chargeback represents an
amount payable in the future to a wholesaler for the difference between the
invoice price paid to the Company by our wholesale customer for a particular
product and the negotiated contract price that the wholesalers customer pays
for that product. The Companys
chargeback provision and related reserve vary with changes in product mix,
changes in customer pricing and changes to estimated wholesaler inventory. The provision for chargebacks also takes into
account an estimate of the expected wholesaler sell-through levels to indirect
customers at contract prices. The
Company validates the chargeback accrual quarterly through a review of the
inventory reports obtained from its largest wholesale customers. This customer inventory information is used
to verify the estimated liability for future chargeback claims based on
historical chargeback and contract rates.
These large wholesalers represent 85% - 90% of the Companys chargeback
payments. The Company continually monitors
current pricing trends and wholesaler inventory levels to ensure the liability
for future chargebacks is fairly stated. The following table summarizes the activity
in the Companys major categories of SRA (in thousands):

Basic earnings per
share is computed by dividing net income by the weighted average common shares
outstanding during a period. Diluted
earnings per share is based on the treasury stock method and includes the
effect from potential issuance of common stock, such as shares issuable upon
conversion of the $575 million convertible contingent senior debentures (CODES),
and the dilutive effect of stock options and restricted stock awards
outstanding during the period. Potential
common shares have been excluded where their inclusion would be
anti-dilutive. In accordance with
Emerging Issues Task Force (EITF) Issue No. 04-8, The Effect of Contingently
Convertible Debt on Diluted Earnings per Share, the Company is required to add
approximately 14.4 million shares associated with the conversion of the CODES
to the number of shares outstanding for the calculation of diluted earnings per
share for all periods in which the securities were outstanding. A reconciliation of the numerators and
denominators of basic and diluted earnings per share consisted of the following
(in thousands, except per share amounts):

Three months ended

Six months ended

June 30,

June 30,

2007

2006

2007

2006

Restated

Restated

Earnings
(loss) per share - basic

Net income (loss)

$

36,409

$

(15,611

)

$

68,021

$

9,563

Basic weighted average common shares outstanding

102,093

101,666

102,178

101,742

Earnings (loss) per share - basic

$

0.36

$

(0.15

)

$

0.67

$

0.09

Earnings
(loss) per share - diluted

Net income (loss)

$

36,409

$

(15,611

)

$

68,021

$

9,563

Add: Interest expense on CODES, net of tax

2,058



4,001



Net income (loss), adjusted

$

38,467

$

(15,611

)

$

72,022

$

9,563

Basic weighted average common shares outstanding

102,093

101,666

102,178

101,742

Effect of dilutive securities:

Conversion of CODES

14,357



14,357



Dilutive stock options

630



374

383

Diluted weighted average common shares outstanding

117,080

101,666

116,909

102,125

Earnings (loss)
per share - diluted

$

0.33

$

(0.15

)

$

0.62

$

0.09

Stock awards to purchase 7.1 million and 10.4 million
common shares for the three months ended June 30, 2007 and 2006, respectively,
were outstanding but were not included in the computation of diluted earnings
per share because the options were antidilutive. Stock awards to purchase 8.6 million common
shares for the six months ended June 30, 2007 and 2006, respectively, were
outstanding but were not included in the computation of diluted earnings per
share because the options were antidilutive.
Potential common shares related to the CODES convertible into 14.4
million common shares were not included in the computation of diluted earnings
per share for the three and six months ended June 30, 2006 because they were
antidilutive.

In July 2006, the Financial Accounting Standards
Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty
in Income Taxes  An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for the
uncertainty in recognizing income taxes in an organization in accordance with
FASB Statement No. 109 by providing detailed guidance for financial statement
recognition, measurement and disclosure involving uncertain tax positions. FIN 48 requires an uncertain tax position to
meet a more-likely-than-not recognition threshold at the effective date to be
recognized both upon the adoption of FIN 48 and in subsequent periods. FIN 48 is effective for fiscal years
beginning after December 15, 2006. As
the provisions of FIN 48 will be applied to all tax positions upon initial
adoption, the cumulative effect of applying the provisions of FIN 48 will be
reported as an adjustment to the opening balance of retained earnings for that
fiscal year. As a result of the adoption
of FIN 48, the Company recorded a $2.9 million increase in the liability for
unrecognized tax benefits resulting in a decrease to the January 1, 2007
retained earnings balance of $2.9 million (for additional information on the
adoption of FIN 48, see NOTE 9  INCOME TAXES).

In September 2006, the FASB issued Statement of
Financial Accounting Standards (SFAS) No. 157, Fair-Value Measurements (SFAS
157) which defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles and expands disclosures about
fair-value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007. The Company is currently
reviewing SFAS 157 and has not yet determined the impact on its consolidated
financial statements.

In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities  Including an Amendment of FASB Statement
No. 115, (SFAS 159) which is effective for fiscal years beginning after
November 15, 2007. SFAS 159 permits an entity to choose to measure many
financial instruments and certain other items at fair value at specified
election dates. Subsequent unrealized gains and losses on items for which the
fair value option has been elected will be reported in earnings. The Company is
currently reviewing SFAS 159 and has not yet determined the impact, if any, on
its consolidated financial statements.

Effective January 1, 2006, the Company adopted the
modified prospective method of SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R)
which requires the measurement and recognition of compensation expense for all
share-based compensation awards made to employees and directors based on
estimated fair values.

A summary of the changes in the Companys stock option plans during the
six months ended June 30, 2007 is presented below (in thousands, except per
share amounts):

Weighted

Weighted

Average

Average

Remaining

Aggregate

Exercise

Contractual

Intrinsic

Shares

Price

Term (Years)

Value

Outstanding at
December 31, 2006

10,985

$

36.39

Granted

69

30.10

Exercised

(435

)

25.71

Cancelled

(779

)

37.15

Outstanding at
June 30, 2007

9,840

$

36.75

5.3

$

21,207

Vested and
expected to vest at June 30, 2007

9,285

$

37.24

5.1

$

18,837

Options
exercisable at June 30, 2007

7,595

$

39.18

4.5

$

11,422

As of June 30, 2007, the Company had $6.8 million of total unrecognized
compensation expense, net of estimated forfeitures, related to stock option
grants, which will be recognized over the remaining weighted average period of
1.4 years. Total intrinsic value of
stock options exercised for the three months ended June 30, 2007 and 2006 was
$2.1 million and $1.6 million, respectively.
Total intrinsic value of stock options exercised for the six months
ended June 30, 2007 and 2006 was $2.3 million and $1.9 million, respectively.

A summary of the changes in restricted stock grants during the six
months ended June 30, 2007 is presented below (in thousands, except per share
amounts):

Weighted

Weighted

Average

Average

Remaining

Aggregate

Grant Date

Contractual

Intrinsic

Shares

Fair Value

Term (Years)

Value

Restricted
shares outstanding at December 31, 2006

569

$

30.26

1.9

$

17,211

Granted

590

32.38

19,103

Vested

(27

)

29.71

(792

)

Cancelled

(36

)

31.35

(1,122

)

Restricted
shares outstanding at June 30, 2007

1,096

$

31.38

2.1

$

34,400

As of June 30, 2007, the Company had $18.0 million of total
unrecognized compensation expense, net of estimated forfeitures, related to
restricted stock grants, which will be recognized over the remaining weighted
average period of 2.1 years.

On November 3, 2006, the Company acquired all the outstanding shares of
common stock of Andrx in an all-cash transaction for $25 per share, or total
consideration of approximately $1.9 billion.
Andrx, whose capabilities both augment and complement those of Watson,
distributes pharmaceutical products primarily to independent and chain
pharmacies and physicians offices and is considered a leader in formulating
and commercializing difficult-to-replicate controlled-release pharmaceutical
products and selective immediate-release products. As a result of the Andrx Acquisition, Watson
now has three operating segments: Generic, Brand and Distribution.

On March 16, 2006, the
Company acquired Sekhsaria Chemicals Ltd. (Sekhsaria), a private company
located in Mumbai, India that provides active pharmaceutical ingredient and
finished dosage formulation expertise to the global pharmaceutical
industry. The Company acquired all the
outstanding shares of Sekhsaria for approximately $29.5 million plus
acquisition costs. The transaction was
accounted for as a purchase in accordance with SFAS 141, Business
Combinations (SFAS 141) and
accordingly, the assets acquired and liabilities assumed were recorded at fair
value on the acquisition date.

The Company holds an equity
interest in Scinopharm Taiwan Ltd. (Scinopharm). In January 2006, the Company made an
additional investment in Scinopharm of approximately $12.0 million which
increased its ownership interest to approximately 31%. Additionally, the Company has an option,
which expires in October 2007, to acquire an additional 44% interest in
Scinopharm at a cost of approximately $80 million.

NOTE 4 
OTHER INCOME

Other
income consisted of the following (in
thousands):

Three Months Ended June 30,

Six Months Ended June 30,

2007

2006

2007

2006

Earnings on
equity method investments - restated

$

2,284

$

1,658

$

3,723

$

1,373

Gain on sale of
securities

683



2,472

3,695

Other income (expense)

67

(97

)

242

8

$

3,034

$

1,561

$

6,437

$

5,076

As discussed in NOTE 1 
GENERAL, earnings on equity method investments has been restated to account for
our investment in common shares of Andrx prior to the Andrx Acquisition using
the equity method of accounting in accordance with APB 18.

Watson has three reportable
operating segments: Generic, Brand and Distribution. The Generic segment includes off-patent
pharmaceutical products that are therapeutically equivalent to proprietary
products. The Brand segment includes the
Companys lines of Specialty Products and Nephrology products. Watson has
aggregated its Brand product lines in a single segment because of similarities
in regulatory environment, methods of distribution and types of customer. This segment includes patent-protected
products and certain trademarked off-patent products that Watson sells and
markets as Brand pharmaceutical products.
The Company sells its Brand and Generic products primarily to pharmaceutical
wholesalers, drug distributors and chain drug stores in the U.S. Following the Andrx Acquisition, a third
operating segment was added representing the Anda distribution business (Anda). The Distribution segment distributes generic
pharmaceutical products manufactured by third parties to independent
pharmacies, pharmacy chains, pharmacy buying groups and physicians offices in
the U.S. Sales are principally generated
through an in-house telemarketing staff and through internally developed
ordering systems. The Distribution
segment operating results are included in Watson results since the date of the
Andrx Acquisition and exclude sales by Anda of Watson Generic and Brand
products, which are included in their respective segment results.

Other revenue consists primarily of royalties,
commissions, co-promotional revenue and the recognition of deferred revenue
associated with manufacturing, development and licensing arrangements.

11

Net revenues and segment
contribution information for the Companys Generic, Brand and Distribution
segments, consisted of the following:

Inventories
consist of finished goods held for sale and distribution, raw materials and
work-in-process. Included in inventory at June 30, 2007 and December 31, 2006
is approximately $26.6 million and $34.2 million, respectively, of inventory
that is pending approval by the U.S. Food and Drug Administration (FDA) or has
not been launched due to contractual restrictions. This inventory consists of generic
pharmaceutical products that are capitalized only when the bioequivalence of
the product is demonstrated or the product is already FDA approved and is
awaiting a contractual triggering event to enter the marketplace.

12

Inventories
are stated at the lower of cost (first-in, first-out method) or market (net
realizable value) and consisted of the following (in thousands):

During the six months ended
June 30, 2007, the Company made prepayments of the 2006 Credit Facility
totalling $250 million. As a result of
these pre-payments, the Companys results for the three and six months ended
June 30, 2007 reflect a $1.7 and $4.4 million non-cash charge for debt
repurchase charges, respectively. As of
June 30, 2007, $400 million is outstanding under the 2006 Credit Facility.

On January 1, 2007, the Company adopted the provisions of FIN 48. Differences between the amount recognized in
the consolidated financial statements prior to the adoption of FIN 48 and the
amounts reported as a result of adoption have been accounted for as a
cumulative effect adjustment recorded to the January 1, 2007 retained earnings
balance. The adoption of FIN 48
decreased the January 1, 2007, balance of retained earnings by $2.9 million. In
addition, the Company reclassified tax reserves for which a cash tax payment is
not expected in the next twelve months from current to non-current liabilities.

As of the adoption date, the liability for income tax associated with
uncertain tax positions was $69.2 million.
This amount is reduced for timing differences and amounts primarily
arising from business combinations which, if recognized, would be recorded to
goodwill. The net amount of $32.5
million, if recognized, would favorably affect the Companys effective tax
rate.

As of June 30, 2007, the liability for income tax associated with
uncertain tax positions was $46.2 million.
This amount is reduced for timing differences and amounts primarily
arising from business combinations which, if recognized, would be recorded to
goodwill. The net amount of $29.4
million, if recognized, would favorably affect the Companys effective tax
rate.

The Companys continuing
practice is to recognize interest and penalties related to uncertain tax
positions in tax expense. At adoption,
the Company had accrued $6.5 million of interest and penalties (net of tax
benefit) related to uncertain tax positions and, as of June 30, 2007, the
Company had accrued $5.9 million of interest and penalties (net of tax benefit)
related to uncertain tax positions.

The Company conducts business globally and, as a result, it files
federal, state and foreign tax returns. In the normal course of business the
Company is subject to examination by taxing authorities. With few exceptions, the Company is no longer
subject to U.S. federal, state and local, or non-U.S. income tax examinations
for years before 2000. While it is often difficult to predict the final outcome
or the timing of resolution of any particular uncertain tax position, the
Company believes its reserves for income taxes represent the most probable
outcome. The Company adjusts these
reserves, as well as the related interest, in light of changing facts and
circumstances.

The Company anticipates that the total amount of liability for
unrecognized tax benefits may change due to the settlement of audits and the
expiration of statute of limitations in the next 12 months. Through June 30, 2007, the Company paid $4.8
million (net of tax benefit) in settlement of uncertain tax benefits and
accrued interest and penalties.

Watson and its affiliates are involved in various other disputes,
governmental and/or regulatory inspections, inquires, investigations and
proceedings, and litigation matters that arise from time to time in the
ordinary course of business. The process of resolving matters through
litigation or other means is inherently uncertain and it is possible that an
unfavorable resolution of these matters will adversely affect the Company, its
results of operations, financial condition and cash flows.

Phen-fen
litigation. Beginning in late 1997, a number of
product liability suits were filed against Watson, The Rugby Group (Rugby)
and certain other Watson affiliates, as well as numerous other manufacturing
defendants, for personal injuries allegedly arising out of the use of
phentermine hydrochloride. The plaintiffs allege various injuries, ranging from
minor injuries and anxiety to heart damage and death. There are approximately
14 cases, with a total of approximately 65 plaintiffs, pending against
Watson and its affiliates in numerous state and federal courts. Most of the
cases involve multiple plaintiffs, and several were filed or certified as class
actions. The Company believes it will be fully indemnified by Rugbys former
owner, Aventis Pharmaceuticals (Aventis, formerly known as Hoechst Marion
Roussel, Inc., and now known as Sanofi Aventis) for the defense of all
such cases and for any liability that may arise out of these cases. Aventis is
currently controlling the defense of all these matters as the indemnifying
party under its agreements with the Company. Additionally, Watson may have
recourse against the manufacturing defendants in these cases.

Cipro®
Litigation. Beginning in July 2000, a number
of suits were filed against Watson, Rugby and other company affiliates in
various state and federal courts alleging claims under various federal and
state competition and consumer protection laws. Several plaintiffs have filed
amended complaints and motions seeking class certification. As of March 8,
2006, approximately 42 cases had been filed against Watson, Rugby and other
Watson entities. Twenty-two of these actions have been consolidated in the U.S.
District Court for the Eastern District of New York (In re: Ciprofloxacin Hydrochloride Antitrust Litigation,
MDL Docket No. 001383
). On May 20, 2003, the court hearing the consolidated action
granted Watsons motion to dismiss and made rulings limiting the theories under
which plaintiffs can seek recovery against Rugby and the other defendants. On
March 31, 2005, the court hearing the consolidated action granted summary
judgment in favor of the defendants on all of plaintiffs claims, denied the
plaintiffs motions for class certification, and directed the clerk of the
court to close the case. On May 7, 2005, three groups of plaintiffs from
the consolidated action (the direct purchaser plaintiffs, the indirect
purchaser plaintiff purchasers and plaintiffs Rite Aid and CVS) filed notices
of appeal in the United States Court of Appeals for the Second Circuit,
appealing, among other things, the May 20, 2003 order dismissing Watson
and the March 31, 2005 order granting summary judgment in favor of the
defendants. The three appeals were consolidated by the appellate court. The
defendants have moved to transfer the appeal to the United States Court of
Appeals for the Federal Circuit on the ground that patent issues are involved
in the appeal. The plaintiffs have opposed the motion to transfer. The
appellate court has not ruled on the motion or the pending appeal. Other
actions are pending in various state courts, including New York, California,
Kansas, Tennessee, Florida and Wisconsin. The actions generally allege that the
defendants engaged in unlawful, anticompetitive conduct in connection with
alleged agreements, entered into prior to Watsons acquisition of Rugby from
Aventis, related to the development, manufacture and sale of the drug substance
ciprofloxacin hydrochloride, the generic version of Bayers brand drug, Cipro®
. The actions generally seek declaratory judgment, damages, injunctive relief,
restitution and other relief on behalf of certain purported classes of
individuals and other entities. The courts hearing the cases in New York have
dismissed the actions. Plaintiffs have sought leave to appeal the dismissal of
the New York action. In Wisconsin, the plaintiffs appealed and on May 9,
2006, the appellate court reversed the order of dismissal. On June 8,
2006, the defendants filed a petition for review in the Wisconsin Supreme
Court. On July 13, 2007, the Wisconsin Supreme Court affirmed the decision
of the appellate court, and remanded the case for further proceedings. In the action pending in Kansas, the court
has stayed the matter pending the outcome of the appeal in the consolidated
case. In the action pending in the California Superior Court for the County of
San Diego (In re: Cipro Cases I &
II, JCCP Proceeding Nos. 4154 & 4220), on July 21,
2004, the California Court of Appeal granted in part and denied in part the
defendants petition for a writ of mandate seeking to reverse the trial courts
order granting the plaintiffs motion for class certification. Pursuant to the
appellate courts ruling, the majority of the plaintiffs will be permitted to
pursue their claims as a class. On April 13, 2005, the Superior Court
granted the parties joint application to stay the California case pending the
outcome of the appeal of the consolidated case. In addition to the pending
actions, Watson understands that various state and federal agencies are
investigating the allegations made in these actions. Aventis has agreed to
defend and indemnify Watson and its affiliates in connection with the claims
and investigations arising from the conduct and agreements allegedly undertaken
by Rugby and its affiliates prior to Watsons acquisition of Rugby, and is
currently controlling the defense of these actions.

15

Governmental
Reimbursement Investigations and Drug Pricing Litigation
In November 1999, Schein Pharmaceutical, Inc., now known as Watson
Pharma, Inc. (Watson Pharma) was informed by the U.S. Department of
Justice that Watson Pharma, along with numerous other pharmaceutical companies,
is a defendant in a qui tam action brought in 1995 under the U.S. False Claims
Act currently pending in the U.S. District Court for the Southern District of
Florida. Watson Pharma has not been served in the qui tam action. A qui tam
action is a civil lawsuit brought by an individual for an alleged violation of
a federal statute, in which the U.S. Department of Justice has the right to
intervene and take over the prosecution of the lawsuit at its option. Pursuant
to applicable federal law, the qui tam action is under seal and, at this time,
no details are available concerning, among other things, the various theories
of liability against Watson Pharma or the amount of damages sought from it. A
qui tam action filed in the same court in 1995 has been partially unsealed,
after the U.S. Department of Justice intervened, against three other
pharmaceutical companies (In re Pharmaceutical
Industry Average Wholesale Price Litigation, United States of America ex rel.
Ven-a-Care of the Florida Keys, Inc., v. Abbott Laboratories, et al., U.S.
District Court for the District of Massachusetts, Civil Action No.
01-12257-PBS). That action
may be the same qui tam action as the one pending against Watson Pharma. The judge to whom that case has been assigned
recently issued opinions denying certain defendants Motions to Dismiss.

The Company
believes that the qui tam action against the Company, which is still under
seal, relates to whether allegedly improper price reporting by pharmaceutical manufacturers
led to increased payments by Medicare and/or Medicaid. The qui tam action may
seek to recover damages from Watson Pharma based on its price reporting
practices. Watson Pharma subsequently also received and responded to notices or
subpoenas from the Attorneys General of various states, including Florida,
Nevada, New York, California and Texas, relating to pharmaceutical pricing
issues and whether allegedly improper actions by pharmaceutical manufacturers
led to excessive payments by Medicare and/or Medicaid.

On June 26,
2003, the Company received a request for records and information from the U.S.
House Committee on Energy and Commerce in connection with that committees
investigation into pharmaceutical reimbursements and rebates under Medicaid.
The Company produced documents in response to the request. Other state and
federal inquiries regarding pricing and reimbursement issues are anticipated.

Beginning in
July 2002, the Company and certain of its subsidiaries, as well as
numerous other pharmaceutical companies, were named as defendants in various
state and federal court actions alleging improper or fraudulent reporting
practices related to the reporting of average wholesale prices and wholesale
acquisition costs of certain products, and that the defendants committed other
improper acts in order to increase prices and market shares. Some of these
actions have been consolidated in the U.S. District Court for the District
of Massachusetts (In re: Pharmaceutical
Industry Average Wholesale Price Litigation, MDL Docket No. 1456). The consolidated amended complaint in that
case alleges that the defendants acts improperly inflated the reimbursement
amounts paid by various public and private plans and programs. The amended
complaint alleges claims on behalf of a purported class of plaintiffs that paid
any portion of the price of certain drugs, which price was calculated based on
its average wholesale price, or contracted with a pharmacy benefit manager to
provide others with such drugs. The Company has filed Answers to the various
amended consolidated class action complaints, and has opposed, with other
defendants, the plaintiffs Motion for Leave to File a Fifth Amended Master
Consolidated Class Action Complaint. Defendants in the consolidated litigation
have been divided into two groups. The Company and its named subsidiaries are
contained in a large group of defendants (the Track Two Defendants) that is
currently awaiting a ruling on the plaintiffs request for certification of
classes of plaintiffs to maintain a class action against the drug company
defendants. Certain other defendants, referred to as the Track One
defendants, have proceeded on a more expedited basis. The presiding judge in
the matter granted class certification with respect to certain companies and
individuals in the group of Track One Defendants. A trial was held with respect
to some of the claims against this group of defendants, and the judge ruled in
favor of the Plaintiffs as to some defendants and awarded damages. All of the Track One Defendants agreed to
settle claims filed on behalf of one of the classes certified in that case, and
some of the Track One Defendants have agreed to settle with all of the classes
certified in that case. The presiding
judge has ordered the Company and other Track Two Defendants to enter mediation
proceedings to explore the possibility of settling some or all of the claims
pending in that case.

The Company and
certain of its subsidiaries also are named as defendants in various lawsuits
filed by the Attorneys General of numerous states, including Nevada, Montana,
Massachusetts, Wisconsin, Kentucky, Alabama, Illinois, Mississippi, Florida,
Arizona, Missouri, Alaska, Hawaii, Idaho, and South Carolina (State of Nevada v. American Home Products, et al.,
Civil Action No. 02-CV-12086-PBS, United States District Court for
the District of Massachusetts; State of Montana v. Abbott Laboratories, et al.,
Civil Action No. 02-CV-12084-PBS, United States District Court for the
District of Massachusetts; Commonwealth of Massachusetts v. Mylan Laboratories,
et al., Civil Action No. 03-CV-11865-PBS, United States District
Court for the District of Massachusetts; State of Wisconsin v. Abbott
Laboratories, et al., Case No. 04-cv-1709, Wisconsin Circuit Court for Dane
County; Commonwealth of Kentucky v. Alpharma, Inc., et al., Case Number
04-CI-1487, Kentucky Circuit Court for Franklin County; State of Alabama v.
Abbott Laboratories, Inc. et al., Civil Action No. CV05-219, Alabama
Circuit Court for Montgomery County; State of Illinois v. Abbott
Laboratories, Inc. et al., Civil Action No. 05-CH-02474, Illinois
Circuit Court for Cook County; State of Mississippi v. Abbott
Laboratories, Inc. et al., Civil Action No. G2005-2021 S/2,
Mississippi Chancery Court of Hinds County; State of Florida ex rel.
Ven-A-Care, Civil Action No 98-3032G, Florida Circuit Court in Leon
County; State of Arizona ex rel. Terry Goddard, No. CV 2005-18711, Arizona
Superior Court for Maricopa County; State of Missouri ex rel. Jeremiah W. (Jay)
Nixon v. Mylan Laboratories, et al, Case no. 054-2486, Missouri Circuit Court
of St. Louis. State of Alaska v. Alpharma Branded Products Division Inc., et
al., In the Superior Court for the State of Alaska Third Judicial District at
Anchorage, C.A. No. 3AN-06-12026 CI. State of Idaho v. Alpharma USPD
Inc. et al., In the District Court of the Fourth Judicial District of the State
of Idaho, in and for the County of Ada, C.A. No. CV-0C-0701847; State of
South Carolina and Henry D. McMaster v. Watson Pharmaceuticals
(New Jersey), Inc., In the Court of Common Pleas for the Fifth
Judicial Circuit, State of South Carolina, County of Richland, C.A.
No. 2006-CP-40-7152; State of South Carolina and Henry D. McMaster v.
Watson Pharmaceuticals (New Jersey), Inc., In the Court of Common Pleas
for the Fifth Judicial Circuit, State of South Carolina, County of Richland,
C.A. No. 2006-CP-40-7155; State of Hawaii v. Abbott
Laboratories, Inc. et al., In the Circuit Court of the First Circuit,
State of Hawaii, C.A. No. 06-1-0720-04 EEH).

16

These cases
generally allege that the defendants caused the states to overpay pharmacies
and other providers for prescription drugs under state Medicaid Programs by
inflating the reported Average Wholesale Price or Wholesale Acquisition Cost,
and by reporting false prices to the United States government under the Best
Prices rebate program. Several of these cases also allege that state residents
were required to make inflated copayments for drug purchases under the federal
Medicare program, and companies were required to make inflated payments on
prescription drug purchases for their employees or insured beneficiaries. These
cases, some of which have been removed to federal court, are in the early
stages of pleading or are proceeding through pretrial discovery. On
January 20, 2006, the Company was dismissed without prejudice from the
actions brought by the States of Montana and Nevada because the Company was not
timely served.

The City of New
York filed an action in the United States District Court for the Southern
District of New York on August 4, 2004, against the Company and numerous
other pharmaceutical defendants alleging similar claims. The case was
transferred to the United States District Court for the District of
Massachusetts, and was consolidated with several similar cases filed by
individual New York counties. A corrected Consolidated Complaint was filed
on June 22, 2005 (City of New York v.
Abbott Laboratories, Inc., et al., Civil Action No. 01-CV-12257-PBS,
United States District Court for the District of Massachusetts). The
Consolidated Complaint included as plaintiffs the City of New York and 30 New
York counties. Since the filing of the Consolidated Complaint, cases
brought by a total of 14 additional New York counties have been transferred to
the District of Massachusetts. The Company is now named as a defendant in cases
brought by the City of New York and 44 New York counties, consolidated in the
District of Massachusetts case. An additional action raising similar
allegations was filed by Orange County, New York, on April 5, 2007, and the
Company was served with a copy of the Complaint in that case on April 25, 2007
(County of Orange v. Abbott Laboratories,
Inc., et al. , United States District Court for the Southern
District of New York, Case No. 07-CV-2777).

Additional actions
by other states, cities and/or counties are anticipated. These actions, if
successful, could adversely affect the Company and may have a material adverse
effect on the Companys business, results of operations, financial condition
and cash flows.

FDA Matters.
In May 2002, Watson reached an agreement with the FDA on the terms of a
consent decree with respect to its Corona, California manufacturing facility.
The court approved the consent decree on May 13, 2002 ( United States
of America v. Watson Laboratories, Inc., and Allen Y. Chao , United States District Court for the
Central District of California, EDCV-02-412-VAP). The consent decree with the
FDA does not require any fine, a facility shutdown, product recalls or any
reduction in production or service at the Companys Corona facility. The
consent decree applies only to the Corona facility and not other manufacturing
sites. The decree requires Watson to ensure that its Corona, California
facility complies with the FDAs cGMP regulations. Pursuant to the agreement,
Watson hired an independent expert to conduct inspections of the Corona
facility at least once each year. In February 2003, February 2004,
January 2005, January 2006 and January 2007, respectively, the
first, second, third, fourth and fifth annual inspections were completed and
the independent expert submitted its report of the inspection to the FDA. In
each instance, the independent expert reported its opinion that, based on the
findings of the audit of the facility, the FDAs applicable cGMP requirements,
applicable FDA regulatory guidance, and the collective knowledge, education,
qualifications and experience of the experts auditors and reviewers, the
systems at Watsons Corona facility audited and evaluated by the expert are in
compliance with the FDAs cGMP regulations. However, the FDA is not required to
accept or agree with the independent experts opinion. The FDA conducted an
inspection of that facility from March 31, 2004 until May 6, 2004. At
the conclusion of the inspection, the FDA issued a Form 483 listing the
observations made during the inspection, including observations related to
certain laboratory test methods and other procedures in place at the facility.
In June 2004 the Company submitted its response to the FDA Form 483
inspectional observations and met with FDA officials to discuss its response,
including the corrective actions the Company had taken, and intended to take,
to address the inspectional observations. The FDA conducted another inspection
of the facility from April 5, 2005 through April 13, 2005. At the
conclusion of the inspection no formal observations were made and no FDA
Form 483 was issued. The FDA conducted another inspection of the facility from
July 9, 2006 through July 21, 2006. At the conclusion of the
inspection no formal observations were made and no FDA Form 483 was
issued. From February 20, 2007 through

17

March 9, 2007, the FDA
conducted another inspection of the facility. At the conclusion of the inspection,
the FDA issued a Form 483 listing the observations made during the
inspection. In April 2007 the Company submitted its response to the FDA
Form 483 inspectional observations, including the corrective actions the
Company has taken to address the inspectional observations. If, in the
future, the FDA determines that, with respect to its Corona facility, Watson
has failed to comply with the consent decree or FDA regulations, including
cGMPs, or has failed to adequately address the observations in the
Form 483, the consent decree allows the FDA to order Watson to take a
variety of actions to remedy the deficiencies. These actions could include
ceasing manufacturing and related operations at the Corona facility, and
recalling affected products. Such actions, if taken by the FDA, could adversely
affect the Company, its results of operations, financial position and/or cash
flows.

Securities
Litigation. Beginning in November 2003,
several securities class action lawsuits were commenced in the United States
District Court for the Central District of California against Watson and
certain of its present and former officers and directors. On February 9,
2004, the federal court issued an order consolidating all of the federal
actions (In re: Watson Pharmaceuticals, Inc. Securities Litigation, Case
No. CV-03-8236 AHM). In addition to the federal consolidated actions, two
shareholder derivative actions were filed in California Superior Court for the
County of Riverside ( Philip Orlando v. Allen Chao, et al., Case
No. 403717; and Charles Zimmerman v. Allen Chao, et al, Case
No. 403715 ). These
federal and state cases all relate to the drop in the price of the Companys
common stock in November 2001, and allege generally that the Company
failed to timely advise investors about matters such as falling inventory
valuations, increased competition and manufacturing difficulties, and
therefore, the Companys published financial statements and public
announcements during 2000 and 2001 were false and misleading. The shareholder
derivative actions were dismissed without prejudice on November 16, 2004.
On August 2, 2004, the United States District Court for the Central
District of California court granted the defendants motion to dismiss the
federal consolidated action, and allowed plaintiffs until August 30, 2004
to file an amended complaint. On August 30, 2004, the lead plaintiff in
the federal consolidated action notified the court that it did not intend to
file an amended complaint in response to the courts order granting the
defendants motion to dismiss. On September 2, 2004, the District Court
entered a judgment of dismissal in favor of the defendants. On October 1,
2004, one of the non-lead plaintiffs in the consolidated action filed a Notice
of Appeal of the dismissal of the action with the United States Court of
Appeals for the Ninth Circuit (Pension Fund v. Watson
Pharmaceuticals, Inc., USCA Docket No. 04-56791). The
court heard oral argument on the appeal on November 17, 2006. On
December 1, 2006, the court ordered appellants to file a new and separate
action against defendants within 28 days or show cause why they had not done
so. Appellants did not file a new and separate action, responding that such a
filing would be time-barred and requesting a ruling on their appeal. As of
August 1, 2007, the appellate court had not ruled on the matter. The Company
believes that it has substantial meritorious defenses and intends to defend the
matters vigorously. However, these actions, if successful, could adversely
affect the Company and could have a material adverse effect on the Companys
business, results of operations, financial condition and cash flows.

Securities
Litigation Against Andrx Corporation. On
October 11, 2005, Jerry Lowry filed a class action complaint on behalf of
purchasers of the Andrxs common stock during the class period (March 9,
2005 through September 5, 2005) in the U.S. District Court for the
Southern District of Florida against Andrx Corporation and its then Chief
Executive Officer, Thomas Rice ( Jerry Lowry
v. Andrx Corporation, et al.,
Case No. 05-61640). The complaint seeks damages under the
Securities Exchange Act of 1934, and alleges that during the class period,
Andrx failed to disclose that its manufacturing facilities were not in compliance
with current Good Manufacturing Practices (cGMP). The complaint further
alleges that Andrxs failure to be cGMP compliant led to the FDA placing Andrx
on Official Action Indicated status, which resulted in not being eligible for
approvals of Andrxs Abbreviated New Drug Applications. On July 24, 2006,
the defendants moved to dismiss the action. On December 8, 2006, the court
granted in part and denied in part the defendants motion to dismiss. On April
18, 2007, plaintiffs filed a motion seeking class certification. Andrx has opposed the motion. Discovery is ongoing. Though we are not in a
position to determine the ultimate outcome of this matter, an adverse
determination of this action could have a material adverse effect on the
Companys business, results of operations, financial condition and cash flows.

Naproxen
Sodium (Naprelan). In October 1998, Elan
Corporation Plc sued Andrx in the United States District Court for the Southern
District of Florida, alleging that Andrxs pending ANDA for a generic version
of Elans Naprelan® infringed Elans patent No. 5,637,320 (Elan Corporation PLC v. Andrx
Pharmaceuticals, Inc.,
Case No. 98-7164). In March 2002, the District Court issued an
order that Elans patent was invalid, and in September 2002, Andrx commenced
selling the 500mg strength of naproxen sodium, its generic version of
Naprelan®. In March 2003, the District Court issued an order denying,
among other things, (i) Elans motion for consideration of the
March 2002 order invalidating its patent, and (ii) Andrxs motion
asking the District Court for a ruling on its non-infringement defenses. Both
parties appealed that March 2003 decision (Elan Corporation PLC v. Andrx Pharmaceuticals, Inc., Case No. 03-1354). On May 5, 2004,
the Federal Circuit Court of Appeals reversed the District Courts
determination that the Elan patent was invalid, and remanded the case back to
the District Court for a determination as to whether Andrxs product infringes
the Elan patent. On July 12, 2005, the Federal Circuit Court of Appeals
issued a decision, in an unrelated case, on how a court should address issues
of claim construction, and the District Court instructed the parties to file
briefs on how the District Court should proceed in this matter in light of the Federal
Circuit Court of Appeals decision. The parties filed their briefs and are
awaiting the courts decision.

18

In
January 2005, Elan filed a complaint in the U.S. District Court for the
Southern District of Florida seeking willful damages as a result of Andrxs
sale of its generic version of Naprelan® (Elan
Corporation PLC v. Andrx Pharmaceuticals, Inc., Case No. 058-60158). In
February 2005, Andrx filed its answer to Elans January 2005
complaint and filed a counterclaim for declaratory relief for unenforceability
due to inequitable conduct and for non-infringement and invalidity of the
applicable patent. This matter has been stayed pending resolution of the
infringement action. Andrx has sold and is continuing to sell its generic
version of the 500mg strength of Naprelan®. Therefore, an adverse determination
could have a material adverse effect on the Companys business, results of
operations, financial condition and cash flows.

Mallinckrodt
Claim. On February 17, 2006, Andrx filed a
complaint against Mallinckrodt in the U.S. District Court for the Southern
District of Florida (Andrx Therapeutics, Inc
v. Mallinckrodt, Inc..,
Case No. 06-60210). The complaint resulted from a dispute over
certain agreements, including a supply and marketing agreement entered into
between Andrx and Mallinckrodt. The complaint sought to establish the parties
rights under the agreements, a judgment declaring that the agreements are still
in force and that Andrx has not defaulted in its obligations. In the
alternative, Andrx sought a judgment for either breach of contract for
anticipatory repudiation or for breach of duty of good faith. On March 10,
2006, Mallinckrodt filed suit against Andrx in state court in Missouri, arising
from the same dispute referenced above (Mallinckrodt, Inc.
v. Andrx Laboratories, Inc., et al., Case No. 06-1000). In its suit,
Mallinckrodt alleged breach of contract, breach of implied covenant of good
faith and fair dealing and sought damages of $9.5 million, along with a
declaratory judgment and injunctive relief. On June 29, 2007, the parties
settled all disputes related to the actions pending in Florida and Missouri,
and the matters were dismissed with prejudice.

Department
of Health and Human Services Subpoena. In
December 2003, the Companys subsidiary, Watson Pharma, received a
subpoena from the Office of the Inspector General (OIG) of the Department of
Health and Human Services. The subpoena requested documents relating to
physician meetings conducted during 2002 and 2003 related to Watson Pharmas
Ferrlecit® intravenous iron product. Watson Pharma provided the requested
documents and has not been contacted again by the OIG for several years.
However, the Company cannot predict what additional actions, if any, may be
taken by the OIG, Department of Health and Human Services, or other
governmental entities.

Hormone
Replacement Therapy Litigation. Beginning in
early 2004, a number of product liability suits were filed against the Company
and certain Company affiliates, for personal injuries allegedly arising out of
the use of hormone replacement therapy products, including but not limited to
estropipate and estradiol. These complaints also name numerous other
pharmaceutical companies as defendants, and allege various injuries, including
ovarian cancer, breast cancer and blood clots. Approximately ninety cases are pending
against Watson and/or its affiliates in state and federal courts representing
claims by approximately 142 plaintiffs. Many of the cases involve multiple
plaintiffs. The majority of the cases have been transferred to and consolidated
in the United States District Court for the Eastern District of Arkansas ( In re: Prempro Products Liability Litigation, MDL
Docket No. 1507 ).
Discovery in these cases is ongoing. The Company maintains product liability
insurance against such claims. However, these actions, if successful, or if
insurance does not provide sufficient coverage against the claims, could adversely
affect the Company and could have a material adverse effect on the Companys
business, results of operations, financial condition and cash flows.

Watson and its
affiliates are involved in various other disputes, governmental and/or
regulatory inspections, inquires, investigations and proceedings, and
litigation matters that arise from time to time in the ordinary course of
business. The process of resolving matters through litigation or other means is
inherently uncertain and it is possible that an unfavorable resolution of these
matters will adversely affect the Company, its results of operations, financial
condition and cash flows.

19

ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion of our financial condition
and the results of operations should be read in conjunction with the Condensed
Consolidated Financial Statements and notes thereto included elsewhere in this
Quarterly Report on Form 10-Q (Quarterly Report). This discussion contains forward-looking
statements that are subject to known and unknown risks, uncertainties and other
factors that may cause our actual results to differ materially from those
expressed or implied by such forward-looking statements. These risks, uncertainties and other factors
include, among others, those identified under Cautionary Note Regarding
Forward-Looking Statements under Risks Related to our Business in our Annual
Report on Form 10-K for the year ended December 31, 2006 and elsewhere in our
Annual Report and this Quarterly Report.

Watson Pharmaceuticals, Inc. (Watson, the Company we, us or our)
was incorporated in 1985 and is engaged in the development, manufacture, marketing,
sale and distribution of brand and off-patent (generic) pharmaceutical
products. Watson operates manufacturing, distribution, research and
development, and administrative facilities primarily in the United States (U.S.).

On November 3, 2006, the Company acquired all
the outstanding shares of common stock of Andrx Corporation (Andrx) in an
all-cash transaction for $25 per share, or total consideration of approximately
$1.9 billion (the Andrx Acquisition). Andrx distributes pharmaceutical
products primarily to independent and chain pharmacies and physicians offices
and is considered a leader in formulating and commercializing
difficult-to-replicate controlled-release pharmaceutical products and selective
immediate-release products.

In conjunction with the Andrx Acquisition, the Company
recorded a $497.8 million charge to operations in the year ended December 31,
2006, in accordance with Statement of Financial Accounting Standards (SFAS)
No. 141, Business Combinations (SFAS 141), for in-process research and
development (IPR&D) assets acquired that the Company determined had no
alternative future use in their current state. The Companys valuation of
IPR&D projects included over thirty controlled or immediate release
products at various stages of research and development. These IPR&D
projects were valued through discounted cash flow analysis utilizing the income
approach at rates commensurate with their perceived risks, which for these
IPR&D projects ranged between 19%-20%. A partial list of cash flow
considerations utilized for each of the IPR&D projects included an
evaluation of a projects estimated cost to complete, future product prospects
and competition, product lifecycles, expected date of market introduction and
expected pricing and cost structure. The major risks and uncertainties
associated with the timely and successful completion of these IPR&D
projects include delays caused by legal actions brought by the Companys
competitors and the timing of the receipt of necessary regulatory approvals. No
assurances can be given that the underlying assumptions used to prepare the
discounted cash flow analysis will not change or the timely completion of each
project to commercial success will occur. For these and other reasons, actual
results may vary significantly from estimated results.

The charge for IPR&D in the year ended December
31, 2006 related primarily to the acquisition of the following six IPR&D
projects:

In December 2003, Andrx entered into an agreement with
Takeda Chemical Industries, Ltd. (Takeda) to develop and market a combination
product consisting of Andrxs approved 505(b)(2) New Drug Application (NDA)
extended-release metformin and Takedas Actos® (pioglitazone), each of which is administered once a day for the
treatment of type 2 diabetes. The Company is responsible for obtaining
regulatory approval of its extended-release metformin in countries that Takeda
determines it will market the combination product. In addition, the
Company is responsible for the formulation and manufacture of the combination
product and Takeda is responsible for obtaining regulatory approval of and
marketing the combination product, both in the U.S. and in certain other
countries.

In March 2006, Takeda filed an NDA for this
combination product and the NDA is under review by the U.S. Food and Drug
Administration (FDA). Final approval and launch of the product is
dependent, among other things, upon favorable resolution of the Official Action
Indicated (OAI) status at the Companys Davie, Florida manufacturing
facility. If approved and launched, the Company is eligible to receive
future milestone payments and royalties from Takedas sale of this product.

The Companys valuation of this IPR&D project at
the Andrx Acquisition date was $133 million.

On May 2, 2005, Andrx entered into an agreement to
obtain certain exclusive marketing rights for Amphastar Pharmaceuticals, Inc.s
(Amphastars) generic version of Aventis Pharmaceuticals, Inc.s (Aventis)
Lovenox® injectable product. Amphastar submitted
its Abbreviated New Drug Application (ANDA) for generic Lovenox® to the FDA
in March 2003. Amphastars ANDA is the subject of a patent infringement
lawsuit filed by Aventis. Amphastar has not obtained FDA approval for its
product and the product continues to be delayed by a Citizen Petition,
including two supplements, and possibly other factors. Amphastar has submitted
comments to Aventis Citizen Petition and supplements. Our marketing rights for
this product generally extend to the U.S. retail pharmacy market, and we will
receive up to 50% of the net profits, as defined, generated from such sales.

The launch of this product is dependent upon Amphastar
obtaining FDA approval.

The Companys valuation of this IPR&D project at
the Andrx Acquisition date was $33 million.

In 2003 and 2004, Andrx filed ANDAs seeking FDA approval
to market metoprolol succinate extended-release tablets in the 25mg, 50mg,
100mg and 200mg strengths. Andrx was awarded 180-days of market
exclusivity for the 50mg strength. During the second quarter of this
year, the Company announced that pursuant to an agreement with Sandoz, a
subsidiary of Novartis AG (Sandoz), the Company relinquished its rights to a
180-day period of marketing exclusivity for its 50mg strength product. As
a result of Watsons agreement to relinquish its marketing exclusivity, Sandoz
obtained final approval of its ANDA for metoprolol succinate extended-release
50 mg tablets. Watson will be entitled to a share of Sandozs profits on sales
of the product, which began in the third quarter of this year.

Andrx continues to pursue approval of its own pending
ANDAs for metoprolol succinate extended-release tablets. Watson believes that
under current FDA policy, Andrx will be barred from obtaining final approval
until March 18, 2008, when AstraZenecas pediatric study market exclusivity
expires. Final approval and launch of the product is also dependent upon
satisfactorily resolving certain questions from the FDA regarding the ANDAs as
well as favorable resolution of the OAI status at the Companys Davie, Florida
manufacturing facility.

The Companys valuation of this IPR&D project at
the Andrx Acquisition date was $85 million.

Andrx has pending ANDAs for the generic versions of
Concerta® (methylphenidate hydrochloride extended-release tablets) in the 18mg,
27mg, 36mg and 54mg strengths.

In September 2005, ALZA Corporation and McNeil-PPC,
Inc. sued Andrx for patent infringement related to the generic version of
Concerta®. The ANDAs remain under review by the FDA and McNeil-PPC, Inc. has
filed a Citizen Petition relating to approval criteria for Concerta®
generics. Final approval and launch of the product is also dependent upon
favorable resolution of the OAI status at the Companys Davie, Florida
manufacturing facility.

The Companys valuation of this IPR&D project at
the Andrx Acquisition date was $94 million.

Andrx has pending ANDAs for omeprazole delayed-release
capsules, 10mg, 20mg and 40 mg strengths, which is bioequivalent to
Prilosec®. In 2001, AstraZeneca filed suit against Andrx alleging
infringement of a patent (patent no.
6,013,281) (the 281 patent) directed to a process for making an omeprazole
formulation. Andrx filed counterclaims of non-infringement, invalidity and
unenforceability. In May 2004, the district court ruled that the 281
patent was invalid due to obviousness. In April 2007, the U.S. Court of
Appeals for the Federal Circuit affirmed the 2004 District Court decision that
the 281 patent is invalid.

21

Andrx is currently enjoined from selling its generic
version of Prilosec® until October 20, 2007, the date upon which Orange Book
patents 4,786,505 and 4,853,230 expire, including pediatric exclusivity.

The ANDAs remain under review by the FDA. Final
approval and launch of the product is dependent upon favorable resolution of
the OAI status at the Companys Davie, Florida manufacturing facility.
Upon approval and launch, we believe that we are entitled to the 180-day period
of market exclusivity with respect to the generic version of the 40mg strength
of Prilosec®.

The Companys valuation of this IPR&D project at
the acquisition date was $57 million.

Andrx Corporation has pending ANDAs with the FDA for
generic versions of Cardizem® LA (diltiazem HCl extended-release tablets),
120mg, 180mg, 240mg, 300mg, 360mg and 420mg strengths. Andrx initially filed
its ANDA for the 420mg strength on April 25, 2005, with a Paragraph
IV certification and notification to the patent holder. On August 10, 2005,
Biovail Laboratories Intl SRL. (Biovail), which is the holder of the NDA for
Cardizem® LA, initiated a patent infringement lawsuit against the Company for
the 420mg strength in the U.S. District Court for the District of Delaware.
Andrx subsequently amended its initial ANDA submission to include the 120mg,
180mg, 240mg, 300mg and 360mg strengths, along with a related Paragraph IV
certification and notice letter. On October 14, 2005, Biovail initiated a
patent infringement lawsuit on the remaining strengths.

The ANDAs remain under review by the FDA. Final
approval and launch of the product is dependent upon favorable resolution of
the OAI status at the Companys Davie, Florida manufacturing facility, as well
as expiration of the statutory 30-month stay of approval. The Company
believes that Andrx is the first ANDA applicant with a Paragraph IV
certification for each of the six strengths, and accordingly may be entitled to
180 days of market exclusivity under the Hatch-Waxman Act.

The Companys valuation of this IPR&D project at
the Andrx Acquisition date was $12 million.

Prior to the Andrx Acquisition, the Company held
common shares in Andrx, which were previously classified as available-for-sale
securities and recorded at fair value based upon quoted market prices with
temporary differences between cost and fair value presented as accumulated
other comprehensive income within stockholders equity, net of any related tax
effect. As required by Accounting Research Bulletin (ARB) No. 51, Consolidated
Financial Statements (ARB 51), earnings (loss) on equity method investments
has been restated for the three and six months ended June 30, 2006 to account for our investment in common
shares of Andrx using the equity method of accounting in accordance with
Accounting Principles Board (APB) Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock (APB 18). Other comprehensive
income has also been restated for the three and six months ended June 30,
2006 to reflect these changes.

Prescription pharmaceutical products in the U.S. are generally marketed
as either generic or brand pharmaceuticals.
Generic pharmaceutical products are bioequivalents of their respective
brand products and provide a cost-efficient alternative to brand products.
Brand pharmaceutical products are marketed under brand names through programs
that are designed to generate physician and consumer loyalty.

Watson has three reportable operating segments: Generic, Brand and
Distribution. The Generic segment
includes off-patent pharmaceutical products that are therapeutically equivalent
to proprietary products. The Brand
segment includes the Companys lines of Specialty Products and Nephrology
products. Watson has aggregated its Brand product lines in a single segment
because of similarities in regulatory environment, methods of distribution and
types of customer. This segment includes
patent-protected products and certain trademarked off-patent products that
Watson sells and markets as Brand pharmaceutical products. The Company sells its Brand and Generic
products primarily to pharmaceutical wholesalers, drug distributors and chain
drug stores. The Distribution segment
was acquired as part of the Andrx Acquisition representing the Andrx Anda
division. The Distribution segment
mainly distributes generic pharmaceutical products manufactured by third
parties, as well as by Watson, primarily to independent pharmacies, pharmacy
chains, pharmacy buying groups and physicians offices. Sales are principally generated through an
in-house telemarketing staff and through internally developed ordering
systems. The Distribution segment operating
results exclude sales by Anda of products reported in Watsons Generic and
Brand segments.